Avery Dennison: Investor Day Highlights The Bullish Medium-Term Growth Path
Summary
- Avery Dennison outlines a new set of medium-term targets at its latest investor day event.
- RFID remains the growth driver, although trends in the IHM business look promising as well.
- Additional capital deployment via M&A and buybacks could provide incremental upside.
- Shares trade at a warranted in-line valuation to peers, with plenty of room for multiple expansion considering its industry-leading top and bottom-line growth potential.
In its first investor day event since 2017, Avery Dennison (NYSE:AVY) laid out a positive set of top and bottom-line targets that signal plenty of earnings growth ahead. Coupled with AVY's demonstrated track record of exceeding prior longer-term targets and optionality from M&A-led growth, I see an upside bias to these targets going forward. As such, I view AVY's current in-line valuation to consumer chemicals peers as justified, with plenty of room for the multiple to expand further as the company continues to compound EPS at a steady double-digit % rate.
Consolidating Avery's Global Leadership in RFID
The key driver of Avery's overall business remains its industry-leading UHF/RAIN RFID business, with market share now well over 50%, with its share in the apparel space even higher. Thus far, the RFID business has grown its top-line impressively from c. $200 million in fiscal 2016 to c. $500 million in fiscal 2020, with the trajectory set to continue into fiscal 2025 when the business is targeted to reach c. $1 billion (implying a 15-20% CAGR). Driving the growth are key competitive advantages such as its leadership in innovation, economies of scale, and a proven go-to-market strategy which should support further product adoption.
Source: Avery Dennison Investor Day Presentation Slides
Additionally, increased RFID adoption in non-apparel markets could support growth beyond 20%/year over the medium-term. Avery will be mainly focused on the food category, which represents the largest opportunity at a c. 200 billion units addressable market size (c. 5x that of the apparel market's c. 40 billion units) and a comparatively low RFID penetration rate. Logistics is another key opportunity, with an addressable market size of c. 60 billion units and similarly low penetration rates. With the COVID-19-led surge in e-commerce demand driving increased complexity in logistics, I see the adoption of RFID technology accelerating as it enables improved visibility and faster sortation times for the last mile.
Source: Avery Dennison Investor Day Presentation Slides
IHM Adds to Favorable Secular Growth and Margin Expansion Opportunities
Although RFID will drive much of the growth, Avery also sees GDP plus longer-term growth in the IHM ("Industrial and Healthcare Materials") business, on the back of favorable secular tailwinds across lightweighting, the conversion from mechanical fasteners to tapes and adhesives, and noise reduction. In the near term, IHM also looks set to deliver above-trend growth post-COVID-19 considering its higher cyclical end-market exposure (recall that organic growth declined by c. 9% in fiscal 2020).
Source: Avery Dennison Investor Day Presentation Slides
The top-line growth will be accompanied by further improvements in the margin profile, which is positive considering EBITDA margins are already up c. 200bps over the last few years. Key margin drivers include improved cost efficiency and a rationalized footprint, along with the potential to leverage LGM ("Label and Graphic Materials") capabilities across operations, procurement, and R&D. With management also remaining open to future bolt-on opportunities similar to its recent acquisition of JDC Solutions (a manufacturer of pressure-sensitive specialty tapes in North America), I see upside to the segment-level targets going forward.
Updated Five-Year Targets Seem Achievable
Looking ahead, Avery projects a top-line growth CAGR of 5+% through fiscal 2025, with revenue drivers comprising base product growth (c. 1.5%), high-value product growth ex-RFID (c. 2%, RFID growth (1.5-2.0%), and completed M&A contribution (0.2%). This implies Avery will reach an impressive c. $9 billion in sales by fiscal 2025 (up from c. $7 billion in fiscal 2020). There also remains plenty of room for margin expansion, mainly driven by RBIS-focused SG&A cost actions and other productivity initiatives, along with gross margin improvements from a shift toward higher-value categories. In aggregate, the top-line growth outlook, margin expansion, and targeted repurchase plan should drive medium-term EPS growth of c. 10%.
Source: Avery Dennison Investor Day Presentation Slides
The fact that Avery's latest set of medium-term targets are also largely in line with its prior cycle is encouraging, as it highlights the consistency of the growth trajectory. As the company continues to leverage its scale and capabilities in labels and adhesive materials to higher growth/higher-margin applications, I view the current targets as achievable, if not conservative, and based on its performance through the last cycle, I see upside to these numbers ahead.
Capital Allocation Offers Additional Upside
One key upside source will likely be the pace and accretion from potential M&A. Considering the current M&A focus on penetrating high-value categories (currently contributing c. $2.7 billion of revenue), successful execution should boost profitability going forward. Supporting this view is the fact that the company already has a track record of M&A success, with the acquisitions of Mactac in 2016, Hanita Coatings in 2017, and Smartrac in 2019, all enabling increased penetration into their respective segments.
Source: Avery Dennison Investor Day Presentation Slides
Over the fiscal 2021-2025 period, Avery is targeting a cumulative ~$6.2-$6.7 billion capital available for deployment, of which $4.5-$5 billion will come from operating cash flow, c. $0.7 billion from the current leverage capacity, and the remaining c. $1 billion from additional leverage capacity in line with the targeted EBITDA growth. Of these, the company expects to utilize c. 50% for buybacks and M&A, but with leverage still well below its target 2.3-2.6x net debt to adjusted EBITDA range, I see room for upside with incremental cash deployment.
Final Take
Despite the near-term volatility coming off a COVID-19 impacted year, I see a clear path toward AVY regaining its steady organic growth trajectory going forward. Key to this will be growth in RFID, which should continue to sustain c. 20% annualized growth on the back of secular non-apparel and logistics tailwinds (accelerated by COVID-19). With AVY positioned to achieve consistent, double-digit EPS growth over the medium to longer-term, I view AVY's in-line valuation to peers in the consumer chemicals space like Sherwin-Williams (SHW), RPM International (RPM), PPG Industries (PPG), International Flavors & Fragrances (IFF), Ecolab (ECL) as justified, with plenty of room for the multiple to expand further as the company continues to outpace its growth targets.
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